Borrowing against a 401(k): a very bad idea

×

As the threat of foreclosure continues to mount for many homeowners, the temptation to borrow against a 401(k) increases. Very bad idea, yet one that occurred to 13-19% more 401(k) holders in 2007. A recent article in CFO Magazine details a few of the ugly scenarios that can result.

Yes, many companies offer loan programs as part of their 401(k) programs as an incentive to get employees to participate. Employee loans against 401(k) balances are bad for both employers and employees. Not only is it a huge administrative headache for employers, but employees often get caught if their are any discrepancies or inaccuracies in the amortization schedule for repayment. Like the IRS will care that someone in the HR department made a mistake. The employee is solely responsible for any and all payback irregularities.

One of the advantages of participating in a 401(k) program is to take advantage of the free money from matching employer contributions as well as compound interest on contributions. Neither of these advantages occur when an employee stops making new contributions and merely repays the borrowed amount. Problems mount exponentially if an employee loses his or her job while owing money against the 401(k) balance. Just when the employee is most at financial risk, the outstanding amount must be repaid in full or the IRS will consider the loan or withdrawal as ordinary income and tax it accordingly. There is a 10% penalty if the borrower is under age 59 1/2.

The IRS does allow for hardship withdrawals from a 401(k) to avoid foreclosure of a primary residence, but the long term savings consequences are staggering. A 5 year, $8,200 loan can have a $62,000 impact on the 401(k) bottom line. Cutting expenses, renegotiating with creditors, getting a second job, are just a few of the much better alternatives for financially strapped homeowners.


Increase your money and finance knowledge from home

Building Credit from Scratch

Start building credit...now.

View Course »

How to Buy a Car

How to get the best deal and buy a car with confidence.

View Course »

TurboTax Articles

E-file: Income Tax Return Electronic Filing

Forget that paper tax return! Electronic filing (e-filing), online tax preparation and online payment of taxes are getting more popular every year. If you've wondered about e-filing, here are the answers to frequently asked questions, including why e-filing is a good idea, which states let you e-file, how much e-filing costs, and how soon you'll receive your refund.

Multiple States - Where To File

Learn where to file state income taxes, even if you're in the military, or earned money in multiple states. TurboTax will calculate how much you owe to the different states where you have earned income.

Will Medicare/Medicaid be Impacted by ACA?

The Affordable Care Act put in place significant tax-related programs that impact Medicare and Medicaid, such as increased Medicare taxes on earned and unearned income, and Medicaid changes designed to increase the number of insured individuals. Establishing whether you are affected by the ACA-imposed taxes, or are eligible for certain health programs that fall under the Centers for Medicare and Medicaid Services, is determined by filing your income tax.

Add a Comment

*0 / 3000 Character Maximum